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Phu My Hung Net Present Value (NPV) / MBA Resources

Introduction to Net Present Value (NPV) - What is Net Present Value (NPV) ? How it impacts financial decisions regarding project management?

NPV solution for Phu My Hung case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Phu My Hung case study is a Harvard Business School (HBR) case study written by John D. Macomber, Dawn Lau. The Phu My Hung (referred as “Promoters Lieu” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, International business, Policy.

The net present value (NPV) of an investment proposal is the present value of the proposal’s net cash flows less the proposal’s initial cash outflow. If a project’s NPV is greater than or equal to zero, the project should be accepted.

NPV = Present Value of Future Cash Flows LESS Project’s Initial Investment






Case Description of Phu My Hung Case Study


Privately held city development promoters decide whether to partner on next phase or go it alone in 20 year, 4000 acre project. Set outside of Ho Chi Minh City, Vietnam, this decades long project led by two Taiwanese families reshaped and built the economic environment of Vietnam's financial capital. The promoters had a long term vision and left very substantial capital invested for a very long time. This allowed them to follow a master plan that was resource efficient, economically attractive, and environmentally friendly (largely due to major up front investments in power and water infrastructure). This project was promoted by industrialists with a system view and patient capital, as compared to governments with limited execution capability or real estate investors with limited capital and a shorter time horizon. The dilemma in the case is about whether or not to partner with an outside retail real estate firm in order to reduce execution and lease-up risk in a proposed new shopping mall; or whether to go it alone with the promoters's own capital doing it the promoter's own way. This expands into a discussion of the same historic choices in the project, and whether the promoters realized a below market return for their methodology. The project is quite successful and transformational today, so the opposite question can also be drawn out: is this the preferred means for promoting multiple new sustainable and competitive cities around the world, with long view private promoters in lieu of government alone and in lieu of real estate developers alone?


Case Authors : John D. Macomber, Dawn Lau

Topic : Finance & Accounting

Related Areas : International business, Policy




Calculating Net Present Value (NPV) at 6% for Phu My Hung Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10026019) -10026019 - -
Year 1 3443878 -6582141 3443878 0.9434 3248942
Year 2 3959732 -2622409 7403610 0.89 3524147
Year 3 3963541 1341132 11367151 0.8396 3327865
Year 4 3239758 4580890 14606909 0.7921 2566192
TOTAL 14606909 12667146




The Net Present Value at 6% discount rate is 2641127

In isolation the NPV number doesn't mean much but put in right context then it is one of the best method to evaluate project returns. In this article we will cover -

Different methods of capital budgeting


What is NPV & Formula of NPV,
How it is calculated,
How to use NPV number for project evaluation, and
Scenario Planning given risks and management priorities.




Capital Budgeting Approaches

Methods of Capital Budgeting


There are four types of capital budgeting techniques that are widely used in the corporate world –

1. Payback Period
2. Profitability Index
3. Internal Rate of Return
4. Net Present Value

Apart from the Payback period method which is an additive method, rest of the methods are based on Discounted Cash Flow technique. Even though cash flow can be calculated based on the nature of the project, for the simplicity of the article we are assuming that all the expected cash flows are realized at the end of the year.

Discounted Cash Flow approaches provide a more objective basis for evaluating and selecting investment projects. They take into consideration both –

1. Timing of the expected cash flows – stockholders of Promoters Lieu have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.
2. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Promoters Lieu shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.






Formula and Steps to Calculate Net Present Value (NPV) of Phu My Hung

NPV = Net Cash In Flowt1 / (1+r)t1 + Net Cash In Flowt2 / (1+r)t2 + … Net Cash In Flowtn / (1+r)tn
Less Net Cash Out Flowt0 / (1+r)t0

Where t = time period, in this case year 1, year 2 and so on.
r = discount rate or return that could be earned using other safe proposition such as fixed deposit or treasury bond rate. Net Cash In Flow – What the firm will get each year.
Net Cash Out Flow – What the firm needs to invest initially in the project.

Step 1 – Understand the nature of the project and calculate cash flow for each year.
Step 2 – Discount those cash flow based on the discount rate.
Step 3 – Add all the discounted cash flow.
Step 4 – Selection of the project

Why Finance & Accounting Managers need to know Financial Tools such as Net Present Value (NPV)?

In our daily workplace we often come across people and colleagues who are just focused on their core competency and targets they have to deliver. For example marketing managers at Promoters Lieu often design programs whose objective is to drive brand awareness and customer reach. But how that 30 point increase in brand awareness or 10 point increase in customer touch points will result into shareholders’ value is not specified.

To overcome such scenarios managers at Promoters Lieu needs to not only know the financial aspect of project management but also needs to have tools to integrate them into part of the project development and monitoring plan.

Calculating Net Present Value (NPV) at 15%

After working through various assumptions we reached a conclusion that risk is far higher than 6%. In a reasonably stable industry with weak competition - 15% discount rate can be a good benchmark.



Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 15 %
Discounted
Cash Flows
Year 0 (10026019) -10026019 - -
Year 1 3443878 -6582141 3443878 0.8696 2994677
Year 2 3959732 -2622409 7403610 0.7561 2994126
Year 3 3963541 1341132 11367151 0.6575 2606093
Year 4 3239758 4580890 14606909 0.5718 1852342
TOTAL 10447237


The Net NPV after 4 years is 421218

(10447237 - 10026019 )








Calculating Net Present Value (NPV) at 20%


If the risk component is high in the industry then we should go for a higher hurdle rate / discount rate of 20%.

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 20 %
Discounted
Cash Flows
Year 0 (10026019) -10026019 - -
Year 1 3443878 -6582141 3443878 0.8333 2869898
Year 2 3959732 -2622409 7403610 0.6944 2749814
Year 3 3963541 1341132 11367151 0.5787 2293716
Year 4 3239758 4580890 14606909 0.4823 1562383
TOTAL 9475811


The Net NPV after 4 years is -550208

At 20% discount rate the NPV is negative (9475811 - 10026019 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Promoters Lieu to discount cash flow at lower discount rates such as 15%.





Acceptance Criteria of a Project based on NPV

Simplest Approach – If the investment project of Promoters Lieu has a NPV value higher than Zero then finance managers at Promoters Lieu can ACCEPT the project, otherwise they can reject the project. This means that project will deliver higher returns over the period of time than any alternate investment strategy.

In theory if the required rate of return or discount rate is chosen correctly by finance managers at Promoters Lieu, then the stock price of the Promoters Lieu should change by same amount of the NPV. In real world we know that share price also reflects various other factors that can be related to both macro and micro environment.

In the same vein – accepting the project with zero NPV should result in stagnant share price. Finance managers use discount rates as a measure of risk components in the project execution process.

Sensitivity Analysis

Project selection is often a far more complex decision than just choosing it based on the NPV number. Finance managers at Promoters Lieu should conduct a sensitivity analysis to better understand not only the inherent risk of the projects but also how those risks can be either factored in or mitigated during the project execution. Sensitivity analysis helps in –

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

Understanding of risks involved in the project.

What are the uncertainties surrounding the project Initial Cash Outlay (ICO’s). ICO’s often have several different components such as land, machinery, building, and other equipment.

What can impact the cash flow of the project.

What will be a multi year spillover effect of various taxation regulations.

Some of the assumptions while using the Discounted Cash Flow Methods –

Projects are assumed to be Mutually Exclusive – This is seldom the came in modern day giant organizations where projects are often inter-related and rejecting a project solely based on NPV can result in sunk cost from a related project.

Independent projects have independent cash flows – As explained in the marketing project – though the project may look independent but in reality it is not as the brand awareness project can be closely associated with the spending on sales promotions and product specific advertising.






Negotiation Strategy of Phu My Hung

References & Further Readings

John D. Macomber, Dawn Lau (2018), "Phu My Hung Harvard Business Review Case Study. Published by HBR Publications.


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